Prior to being acquired by Microsoft in 2016, LinkedIn spun off its cloud software division, Confluent (CFLT -1.11%), in 2014. On June 24, 2021, Confluent went public at $36, and its stock opened at $44 and soared to an all-time high of $93.60 on Nov. 5, 2021. Today, Confluent only trades at about $23.
If you had invested a modest $2,000 in Confluent's initial public offering (IPO), your investment would have blossomed to $5,200 before withering to about $1,278. Let's see why Confluent's stock initially skyrocketed, why it plummeted, and where it might be headed this year.
Image source: Getty Images.
What does Confluent do?
Back in 2011, Jay Kreps, Jun Rao, and Neha Narkhede developed Apache Kafka as an open-source data streaming platform within LinkedIn. The three founders soon realized that Kafka, which was originally used to process data streams filled with billions of messages on LinkedIn, could be marketed to other companies to quickly process their data.
In 2014, Kreps, Rao, and Narkhede officially founded Confluent with an investment of about $500,000 from LinkedIn. In its final funding round in 2020, it was valued at $4.5 billion. It went public with a market capitalization of $11 billion.
Confluent attracted so much attention because it processes "data in motion" instead of static data points like older cloud-based analytics companies. It calls its platform a "connective tissue" that continuously streams real-time data between a client's applications and services to create a "single, central source of truth." In its S-1 filing, it boldly claims that it can become the "central nervous system for modern digital enterprises" as it makes "data in motion core to everything they do."
How fast is Confluent growing?
Confluent has grown like a weed since its IPO. Between 2019 and 2022, its revenue rose at a compound annual growth rate (CAGR) of 58%, while its total number of larger customers that generate more than $100,000 in annual recurring revenue (ARR) increased at a CAGR of 43% from 337 to 991. Its remaining performance obligations (RPO), or the revenue it has yet to recognize from its existing contracts, also jumped, from $160 million at the end of 2019 to $741 million at the end of 2022. But as the following table illustrates, its breakneck growth has decelerated over the past three years.
|
Metric |
2020 |
2021 |
2022 |
|---|---|---|---|
|
Revenue growth |
58% |
64% |
51% |
|
RPO growth |
64% |
91% |
48% |
|
Growth in customers with over $100,000 in ARR |
52% |
43% |
35% |
Data source: Confluent.
In 2023, Confluent expects its revenue to rise 30% to 31%. Like many of its cloud peers, it blames that slowdown on "elongated" sales cycles as companies tighten their software spending to cope with the near-term macro headwinds.
Will it ever turn a profit?
At its peak, Confluent's enterprise value hit $23.7 billion -- or 40 times the revenue it would generate in 2022. That bubbly valuation made it an easy target for the bears as rising interest rates drive investors toward more conservative investments. Today, the stock looks more reasonably valued -- but still not cheap -- at 7 times its 2023 sales.
The other problem with Confluent was its lack of profits. On a generally accepted accounting principles (GAAP) basis, its net loss widened from $230 million in 2020 to $343 million in 2021, then widened to $423 million in 2022. On a non-GAAP (adjusted) basis, which excludes its stock-based compensation and other one-time expenses, its net loss still widened from $88 million in 2020 to $163 million in 2021, then only narrowed slightly to $161 million in 2022.
Confluent's adjusted gross and operating margins both expanded in 2022, but it could still take years for it to break even on a non-GAAP basis. Its high debt-to-equity ratio of 2 could also make it tough to raise fresh cash at reasonable rates.
There are better cloud stocks to buy right now
Confluent's slowing growth, widening losses, and high leverage will make it an unappealing stock as long as interest rates stay high. Even if the macro environment improves, the bulls could avoid Confluent until it proves it can eventually generate a profit. Until then, investors will likely gravitate toward other growth stocks with more attractive fundamentals. Based on all these challenges, I expect Confluent to trade at a discount to its IPO price for at least the rest of 2023.
